Edison Schools Settles SEC Enforcement Action

FOR IMMEDIATE RELEASE2002-67

Commission Finds Inaccuracies in SEC Filings and Inadequate Internal Controls Part of Real Time Enforcement Initiative

Washington, D.C., May 14, 2002 -- The Securities and Exchange Commission today announced a settlement in which it found that Edison Schools Inc. inaccurately described aspects of its business in SEC filings. The Commission found that Edison failed to disclose that a substantial portion of its reported revenues consist of payments that never reach Edison. These funds are instead expended by school districts (Edison's clients) to pay teacher salaries and other costs of operating schools that are managed by Edison. Among other relief, the Commission ordered that Edison add a Director of Internal Audit to its management team.

"This case is an example of real time enforcement at work," said Wayne M. Carlin, Regional Director of the Commission's Northeast Regional Office. "The Commission's Order remedies past disclosure violations and provides for greater transparency in this company's future reporting. The creation of an internal audit function addresses our investigative findings and enhances investor protection. And we have done all of this in three months, from the inception of our inquiry to the resolution announced today."

The Commission did not find that Edison's revenue recognition practices contravene Generally Accepted Accounting Principles (GAAP) or that earnings were misstated. The Commission nonetheless found that Edison committed violations by failing to provide accurate disclosure. Carlin commented, "The Commission's action today shows that technical compliance with GAAP in the financial statements will not insulate an issuer from enforcement action if it makes filings with the Commission that mischaracterize its business, or omit significant information."

The Commission's Order makes the following findings:

Edison, based in New York City, manages approximately 130 schools under agreements with 62 school boards and charter holders. Under a typical management agreement, a school board agrees to pay Edison a fee based on the number of students enrolled in the district's Edison-managed schools ("Per-Pupil Funding"). The agreements with many districts also provide, however, that the district may withhold from its payments to Edison funds sufficient to pay the salaries of teachers (who are employees of the school district) and in many cases to pay other costs of operating the schools (together, these costs are "District-Paid Expenses").

Throughout its existence, Edison has included the total amounts of District-Paid Expenses in both Edison's reported revenues and its reported expenses. In certain circumstances, GAAP requires that expenses paid by another party on behalf of a reporting company be included in the reporting company's revenue. This is referred to as "gross" reporting of revenue.

District-Paid Expenses have comprised the following portions of Edison's reported revenues:

(in millions)

1999

2000

2001

First6 Months2002

Revenues

133

225

376

231

District-Paid Expenses

64

100

154

108

Edison's SEC filings inaccurately stated that Edison "receives" all Per-Pupil Funding. In its most recent Form 10-Q, Edison disclosed for the first time that districts typically deduct from their remittances the amounts they pay in District-Paid Expenses. Edison has never disclosed the magnitude of the District-Paid Expenses. Consequently, Edison's SEC filings have not provided accurate disclosure regarding significant aspects of Edison's business.

Edison cooperated in the Commission's inquiry. Edison and its independent auditor conducted a comprehensive review of Edison's accounting practices. Based on this review and in light of recent clarifications of GAAP, Edison has concluded that revenues from seven districts should exclude amounts paid for teacher salaries going forward. Similarly, Edison has determined that revenues should be reported net of (i.e., excluding) certain other District-Paid Expenses for many districts.

Edison failed to accelerate the recognition of $2.4 million in losses relating to agreements with two districts in the first quarter of 2001, when those losses became probable and estimable.

Edison accounted incorrectly for the proceeds of a warrant sold to a philanthropic entity.

Edison did not account properly for a liability represented by a severance agreement with a senior officer of the company.

Edison does not have in place an adequate accounting system to bill districts for the net amounts actually owing to Edison. Invoices have not set forth a deduction for District-Paid Expenses, and some districts do not even receive invoices from Edison. Edison's inadequate control over the invoicing process and the expenditure of funds by districts results in an inadequate and decentralized accounting system. Edison lacks an internal audit function to address weaknesses in this system.

Edison consented to the issuance of the Commission's Order without admitting or denying the findings. The Commission found that Edison violated Sections 13(a), 13(b)(2)(A) and 13(b)(2)(B) of the Securities Exchange Act of 1934 and Rules 12b-20, 13a-1 and 13a-13 thereunder, and ordered Edison to cease and desist from committing such violations in the future.